Self-Directed Investing: What You Must Know Before Starting

Feb 17, 2015 by Christopher Warner

The popularity of self-directed investing ebbs and flows with the performance of the stock markets. When times are good and nearly every stock is heading upward, more people make the decision to start managing their own investments. During periods like we saw in 2008 and 2009, or the more recent downturn in late 2014 when markets dropped and there was more red than green on the screen, investors scatter in all different directions.

Some choose to cut their losses, bail out of whatever they're holding, and stay in cash until the dust settles while hoping to catch the market on its move back up.

Others decide self-directed investing isn't for them and seek the help of a licensed, professional advisor.

There are some who do nothing but ride out the downturn, believing they are holding good investments that will recover when the market does.

And then, there are those brave souls who see the downturn as a buying opportunity and invest as much new money as they can.

Unfortunately, that final group are among the minority. I once attended a seminar being put on by a former advisor who told an audience of mostly investment advisors "You people are in the only business where, when everything goes on sale, people run away!"

What Kind Of Investor Are You?

One of the first questions I think someone needs to answer prior to entering the world of self-directed investing is "Am I a trader or an investor?" If you decide you're going to be an active trader, or even a day trader, that will mean paying more in commissions and other fees. It also means a lot more time spent in front of the computer watching market activity or attached to a mobile device that can receive alerts when things happen in the market that you want to know about.

Simple Is Usually Best

If you think to yourself "Nope, I don't have the time or desire to be an active trader", you can still be a self-directed investor in a much simpler way, by using index mutual funds and Exchange Traded Funds (ETFs). The management fees are usually low, they provide broad exposure to whatever sector, country, or region they invest in and in the case of index mutual funds, there's almost never a fee to buy or sell. With ETFs, there is usually a commission on both the buy and sell, but even that can be avoided, depending on the brokerage you use to invest.

I believe index funds and ETFs are good for people just getting the hang of investing or for those who don't have much money to get started with. It might feel cool to say that you own shares in XYZ company, but if you can only buy a few shares at a time and don't have enough money to diversify across multiple corporations two things can happen:

First, it takes a more dramatic move in the share price to earn enough to cover the cost the commissions from buying low quantitites of a few individual companies.

Second, the old adage about putting all your eggs in one basket comes to mind.

If something goes horribly wrong with one of the companies you've chosen (like what happened with Enron, WorldCom, Bre-x, Nortel, and Yellow Pages), your entire investment could be lost almost overnight. Index funds and ETFs are far less likely to evaporate with the fortunes of a single company. They also go a long way in preventing you from making brash investing decisions and trying to time the market, which are well proven to be the downfall of many an investor.

Watch Those Fees

Whether you're actively trading or buying and holding for the long term, there are bound to be some fees involved. The self-directed investing space, like anything else, is competitive and prices have been coming down. The key is to shop around for which company has the fee structure that meets your needs.

Commissions

When I opened my first discount brokerage account in the mid 90s, the commissions were $43 per trade. Later I moved to a firm that charged $35 and then eventually to one that was only charging $29 per trade.

These days, many discount brokerages are down to under $10 a trade, and I've seen ads for trading as low as one cent or trading ETFs for free. Whatever company you're thinking of opening an account with, ask questions about the fees.

With some companies the flat rate commission listed might only cover trades up to a certain number of shares, at which point the commission reverts to a per share fee. For example, one company I held an account with charged $29 per trade up to 1,000 shares. If an investor bought or sold more than 1,000 shares in a single trade, the commission changed to three cents per share. So if an investor bought 2,000 shares at once, the commission became $60 instead of the $29 they might have thought they were paying. It's important to review the commission schedule and watch for asterisks that direct you to smaller print with additional details.

Account Fees

Some discount brokers charge a fee if the total value of an account is below a certain dollar amount. Many years ago I received a letter from the discount broker I was dealing with at the time telling me that if my account size was not brought up above a certain dollar amount, they would begin charging me a monthly fee. Rather than bow to that pressure, and because I didn't have the money at the time, I moved my account to another firm that didn't charge a fee based on the balance of the account.

Some account fees are monthly and sometimes they are charged annually. This is especially common with registered accounts like RRSPs. I know of one discount broker that charges a fee of $100 per year if the balance of the RRSP is under $25,000.

Some firms also charge a fee if there is what they consider "insufficient activity" in the account. This fee is often waived for accounts over a certain dollar value, which again is usually found in the small print on the fee schedule.

Data Fees

Some people find it interesting or even 'fun' to watch the stock market move each day. Many investment companies are making live streaming of stock quotes available to their clients, for a fee. Unless you're a day trader trying to catch every movement up or down on a stock, paying for this service probably isn't worth the money.

If you're a buy and hold investor like me, there are plenty of websites that offer stocks quotes. Some are on a delay, while others might provide a real time quote at the moment you call it up but it's not streaming, so it won't change as you watch it. The streaming quote data is fun to watch for a little while but at $10 a month or more, you can get better entertainment value out of a video streaming service.

Wrapping It Up

Whether paying account fees, commissions, or management fees through mutual funds and ETFs, investing has its costs. The key is to do your homework.

If you're comfortable making your own investment decisions, then a discount brokerage is a good option.

If you feel you want access to advice on your investments, people at a discount brokerage are often not licensed to provide investment advice. In that case, it might be better to stick with a bank or a licensed advisor.

Finally, you might also consider a fee-only investment advisor if you want to invest yourself, save some money on fees, and still get qualified advice.

The choice is yours, choose wisely.

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